Shadow Inventory Looms Large over Housing Recovery

The catch phrase in the housing market lately seems to be “shadow inventory.” It pops up more and more often in housing news articles, and it sounds very ominous. The truth is that this scary bogeyman is quite a sinister threat, even though it’s a little hard to define and quantify – like the “real” unemployment number that includes those whose unemployment benefits have run out, those who have given up looking, and those who are seriously underemployed.

Basically, shadow inventory in the housing market is a bit like the cars lined up at the traffic metering lights on the ramp waiting to get on the freeway. We are told that this shadow inventory is decreasing because fewer “cars” entered the freeway from that distressed ramp this month than last month. That’s a good sign, right? Not so fast. The banks control the rate of flow, so instead of letting a car pass every 15 seconds, they’ve slowed the rate down to one car every 20 or 30 seconds. So, less new distressed inventory is coming into the market, but the line of cars waiting in line now stretches farther than the eye can see.

Foreclosures, which took an average of 150 days in normal times and a bit over 300 days before the robo-signing debacle, now take 400 days to complete. So, with less bad debt showing up on their books each month, banks paint a rosy picture of improved profitability, and the housing market trumpets that it’s on the way to recovery. But most of the ice berg lies beneath the surface.

To complicate matters, there are several shades of grey to the shadows. Some houses are foreclosed REOs that banks have not yet put on the market; some are past the sheriff’s sale and/or in the redemption or judicial stage, depending on the state; some have been notified of an impending foreclosure if payments are not brought up to date; some are seriously delinquent but have not yet triggered any action from the bank. And, of course, millions are underwater with financially strapped owners who will not be able to hang on much longer.

Foreclosures are going to be a drag on the housing market for a log time to come. Perhaps slowing the drip rate will help stabilize the market , as long as the shadows don’t get too dark and deceiving. Maybe the best we can hope for is that the market will get comfortable with its constant companion of distressed homes and they will become less of a drag. After all, new cars sold well for many decades on the other side of the same lot from used cars, so maybe we will just end up with a new look to the housing marketplace.